by Jade Thomason
Vice President
Equity and Fixed Income Trading
Prior to the escalation of conflict in Iran, market attention was firmly focused on inflation, highlighted by two report releases this week: January’s Personal Consumption Expenditures (PCE) and February’s Consumer Price Index (CPI). While inflation remains an important economic consideration, developments in the Middle East have quickly become the dominant force influencing capital markets, with no clear indication of how long the uncertainty may persist. The Greek philosopher Heraclitus observed that the only constant is change—a reminder that periods of transition are inherent to both history and markets. Beyond the profound humanitarian consequences in the region, the conflict also carries potential implications for the global economy, particularly through energy markets, trade and investor sentiment.
Inflation
January’s PCE price index—the Federal Reserve’s preferred measure of inflation—showed that overall consumer prices continued to rise at a moderate pace, with the year-over-year rate slightly below expectations. Core PCE, which excludes volatile food and energy costs and is closely watched for underlying inflation trends, remained elevated at around 3.1%, well above the Fed’s long-term 2% target.
The February CPI report showed inflation remained steady. Overall prices rose 2.4% year-over-year, largely in line with economists’ expectations and unchanged from January. Core inflation (excluding food and energy) was about 2.5%, reinforcing the view that underlying price pressures have not accelerated significantly. However, because this data predates recent geopolitical tensions and higher oil prices, many analysts view it as a baseline prior to potential inflationary effects from the conflict in the Middle East.
Even before tensions escalated, the U.S. inflation picture was becoming more complex. An unusual divergence has emerged between the CPI and the PCE index—a gap that has not historically persisted for long periods. CPI, which focuses on out-of-pocket expenses and places greater weight on housing, has moderated, while PCE has remained stubbornly near 3%. While small differences are common, the current spread is wider than normal and, if sustained, could mark the largest gap since the mid-1980s. For investors, this rare divergence reinforces why policymakers are carefully evaluating multiple data points before declaring inflation fully under control.
Middle East Conflict
The war’s ultimate effect on inflation remains difficult to assess. Beyond fluctuations in crude oil prices, analysts are closely monitoring whether shipping disruptions begin to ripple through global supply chains, increasing the costs of commodities such as fertilizers, chemicals and other industrial inputs that rely on stable, affordable transportation. Although gasoline and other energy products account for a relatively modest share of overall consumer spending, approximately 6% by the Labor Department’s estimates, they tend to exert an outsized influence on inflation perceptions due to their visibility and frequency of purchase. Recent swings in oil prices have pushed the national average for regular gasoline meaningfully higher than prior monthly averages, reinforcing consumer sensitivity to energy costs.
The duration of elevated oil prices is equally important. While markets often focus on how high prices climb in the short term, the more consequential question for the broader economy is where they ultimately stabilize. A sharp spike that reverses quickly can typically be absorbed with limited lasting impact on inflation readings, allowing the Federal Reserve to maintain focus on labor market conditions. However, if higher energy prices persist, supply chains may begin to embed those costs more permanently, increasing the risk of broader price pressures and complicating the policy outlook.
Takeaways for the Week
Inflation remains stable, but the ongoing conflict in Iran is putting upward pressure on prices and it is uncertain how long oil prices will stay elevated
Oil prices hover near $100, exceeding the $60-$71 range that was seen in early to mid-February.
The S&P 500 is on pace for its third consecutive weekly decline